Axsys Technologies Q1 2009 Earnings Call Transcript

| About: Axsys Technologies (AXYS)

Axsys Technologies Inc. (AXYS) Q1 2009 Earnings Call April 23, 2009 10:00 AM ET

Executives

Steve W. Bershad - Chairman and Chief Executive Officer

David A. Almeida - Executive Vice President and Chief Financial Officer

Scott B. Conner - President and Chief Operating Officer

Analysts

Stephen Levenson - Stifel Nicolaus

Brian Ruttenbur - Morgan Keegan and Company, Inc.

Paul Coster - JPMorgan

Michael French - Morgan Joseph & Company Inc.

Michael Ciarmoli - Boenning & Scattergood, Inc

Tim Quillin - Stephens, Inc.

Tyler Hojo - Sidoti & Company

Operator

Good day, everyone and welcome to the Axsys Technologies' First Quarter 2009 Financial Results Conference Call. At this time, I would now like to inform you that this conference is being recorded, and that all participants are in a current in a listen-only mode.

This conference call includes forward-looking information that Axsys does not undertake to update or that may not reflect actual results, changes or any assumptions or changes in other factors affecting such forward-looking information. Although, such statements reflect Axsys's current reasonable judgment regarding the direction of the business, the actual results might differ materially from those in the forward-looking statement. Assumptions and other information that could cause actual results to differ materially from those set forth in the forward-looking statements can been found in Axsys's filings with the Securities and Exchange Commission. Any non-GAAP financial information presented in the... will be reconciled to GAAP financial statements on the Investor Relations section on the company's website at www.axsys.com.

I would now like to turn the conference over to Mr. Stephen Bershad, Chief Executive Officer. Please go ahead, sir.

Steve W. Bershad

Thank you, operator. Good morning, everyone and thank you for joining us on Axsys Technology's first quarter conference call. Joining me today as usual are Dave Almeida, our Chief Financial Officer; and Scott Conner, our President.

Today, I'm going to limit my comments to a few brief highlights from the quarter. And then turn the call over to Dave to explain in detail the financial results for the quarter. And after Dave, I'll ask Scott to talk about our outlook for the company in the context of the recent announcement by Defense Secretary, Gates.

As you can see from our release, we started the year on a very strong footing. During the quarter, we experienced strong growth in both our business segments, resulting in record revenues for the company of $66 million, that's actually $66.6 million. And in addition, during the quarter, improved leverage on our operating expenses drove at 37% increase in our net income, compared to the same quarter last year.

Our bookings performance was solid, resulting in ending backlog of $162.1 million. But as important we are... our sales opportunities pipeline is showing very strong growth. Overall, we're very pleased with these results.

Before I turn the call over to Dave, let me turn briefly to our continuing activities in connection with the potential sale of Axsys. While I fully realize that this is a topic about which you are all very interested, and in fact it's a process that consumes a great deal of time and effort on our part. However, due to various legal constraints, all I can tell you at this point of time is that we are satisfied with the progress of the process and it is continuing in accordance with our plan.

Although, we fully appreciate that our investors would like as much information as possible about the status of the process, you should understand that in order to preserve the integrity of the ongoing process, it is difficult for us to disclose any developments until our Board of Directors either approves a specific transaction or decides to terminate the process.

With that in mind, we apologize in advance, but we will not be able to provide any additional information about the potential sale of the company in today's call.

At this point, I'll turn the call over to David to review our quarterly financial results in more detail. David?

David A. Almeida

Thank you, Steve. And good morning everyone. Today, I'll start with the review of our financial results for the quarter. And I will follow that with up to some balance sheet highlights.

Consolidated sales for the first quarter 2009 were 66.6 million, up 18% from 56.4 million in 2008 due to strong growth in both reporting segments. Gross margin for the first quarter was 33.1% in 2009, compared to 34% in 2008. The decline in margin was mainly due to increased overhead associate with the new national facility, and cost related to the ramp of the new large in infrared lens production line.

Operating income increased from 8 million or 14.2% of sales in first quarter of 2008 to 10.9 million or 16.4% of sales in the first quarter of 2009. The year-over-year increase in operating margin was driven by improved leverage of our operating percentages in both business segments. This was achieved while increasing our R&D spending from 3.5% of sales in the first quarter of 2008 to 4.1% of sales in the current quarter, with continued investment in new product development.

Net income was $7 million or $0.61 per diluted share in 2009, up from 5.1 million or $0.45 per diluted share in the comparable quarter last year.

Looking at the segments, the Surveillance Systems Group grew 17% or 17.9 million in the first quarter of 2008 to 20.9 million in the first quarter of 2009. Increase in sales for the quarter was primarily due to continued strong growth for camera systems, particularly for land-based perimeter security and airborne surveillance applications.

Gross margins were roughly flat at 42.4% for the first quarter of 2009, as the impact with higher sales was offset by the increased overheads for the new facility.

Operating income improved to 4.2 million or 20.1% of sales in 2009 from 3.4 million or 19.3% of sales in the comparable quarter of 2008. This was mainly due to expense control that allowed us to increase our operating expense leverage, but simultaneously investing more in R&D.

Sales in the Imaging System segment were 45.7 million for the first quarter of 2009 and 19% increase in sales of 38.5 million in the first quarter of the prior year. The growth was mainly due to strong demand for infrared lenses and precession motion control products. The gross margin in this segment was 28.8% for the first quarter of 2009, compared to 30% last year. The decline was mainly due to inefficiencies related to material logistics, training and implementation of a new production process as we wraps the new production lines.

Operating margin improved from 17.6% in the prior year to 19.4% this year, due to increased leveraged of our operating expenses.

We ended the quarter with a $162.1 million backlog of firm orders, of which approximately 89% of that backlog is scheduled to ship in the subsequent 12 month period.

As usual, I'd like to end comments this morning by providing some brief balance sheet highlights. We ended the first quarter with 26.1 million of cash, up from... up 1.4 million from the end of last year. This was after $802,000 payment for the 2008 Cineflex earn out.

Although our sales growth and timing of shipments within the quarter drove to $7.2 million increase in accounts receivable during the quarter, improved inventory management enabled us to hold our inventory level during the quarter.

We continued to have no definite balance sheet. In 2009, we remained on target to convert approximately 65% of our net income to free cash flow, which will enable us to continue funding our existing operations with internally generated cash flows.

With that, I'll turn the call over to Scott. Scott?

Scott B. Conner

Thanks Dave, and good morning everyone. Typically, I spend much of my time on these calls discussing the detailed bookings and shipments in the quarter. But I think it's important every once in a while to step back and discuss fundamental. So that the investment community does not lose forest for the trees.

Given the recent change in administration and Secretary, Gates announcement of it's spending priority, coupled with the fact that we're evaluating some fundamentally different futures for Axsys, I thought that today was an opportune moment to discuss the reasons while we have such confidence in our company's future.

As evidenced by our first quarter's result, demand remained strong in both segments of the business. And in both segments, this demand is driven by three fundamental factors. First, there is an increasing recognition of the importance in the value of high performance, intelligence, surveillance, reconnaissance and targeting or ISRT capabilities, among defense and homeland security agencies.

Second, rapid advancements in the price for performance of infrared technology, specifically is resulting in an increasing number of new markets and applications for this technology. And third, Axsys continues to rapidly evolve its existing products and develop new ones in order to create new market opportunities.

The combination of these three growth drivers, a demand curve shift for ISRT technology, indiscreet advances down in the elastic infrared technology demand curve and the development of new product has driven Axsys's growth to-date, and will lead to continued success in the future.

I'd like to discuss each of these growth drivers in turn. The increase in demand for ISRT was clearly evident when Secretary of Defense, Gates outlined his priority for the DoD budget earlier in this month. In spite of pressure to control spending in the military, Secretary, Gates specifically announced his intention to increase spending on ISRT capability. This emphasis is completely n line with our expectations and strategies.

The reasons for Secretary, Gates spending emphasis are clear. ISRT enhancements are a relatively low cost way to dramatically increase the effectiveness of security of soldiers and military vehicles, ISRT technology result in significant battlefield advantages over enemy combatants and ISRT technology is a force multiplier, enabling increased military effectiveness with less people.

There is every reason to believe that the markets for surveillance, reconnaissance and targeting technology is poised for continued growth. And that the DoD will always demand solutions with ever increasing levels of performance and cost effectiveness. This commitment was specifically addressed by Secretary, Gates in his recommendation to quote initiate research and development on a number of ISR enhancements and experimental platforms optimized for today's battlefield. ISR clearly has a promising future.

On discussing Secretary, Gates' proposed budget, I would like to briefly address the impact on Axsys of the specific program changes that we recommended. Overall, the specific program details are quite positive for Axsys. First of all, Axsys is only involved with one of the named programs that Secretary, Gates is recommending for cuts; the F22 fighter jets, on which Axsys has only a small amount of content.

Second, if Secretary, Gates recommendations are implemented, there are three programs that would have a very positive impact on Axsys in the coming years. These programs are Standard Missile 3, Terminal High Altitude Area Defense or THAAD and the F-35 Joint Strike Fighter.

The missile defense programs SM-3 and THAAD could result in at least $34 million of revenue over the life of the program. And more importantly, the Joint Strike Fighter could lead to over $80 million of revenue in the next five years and over $350 million over the life of the program.

For company of our size, these are extremely positive developments. Even more important than any single program, however the proposed defense project clearly emphasizes the importance of ISRT technology and finding cost effective solutions for the nation's defense requirement. These two areas of focus are completely inline with our expectations. And in fact we build our entire company around these principles.

Let me now turn to Axsys's second important growth driver. The ongoing improvement in the performance and cost effectiveness of infrared camera system. In the past decade or so, the improvements in infrared technology has been pretty startling. Most of us equate infrared images to white blobs moving across a dark background. However, today's high performance infrared images are so clear that they could almost be mistaken for black and white television. This increased capability, coupled with a steady decline in the cost of these solutions has led to the dramatic increase in the demand for infrared systems for pre-existing applications like weapon sights and border security. And the development of new applications such as remote weapon stations and vehicle mounted surveillance system.

In order to fully appreciate Axsys's potential, it's important to understand that the evolution of this technology is still in it's early stages of development. So, often an analogy, today you can inexpensively buy a commercial 10 mega-pixel digital camera to take pictures of your children. But even single mega-pixel infrared cameras are not yet cost effective for the vast majority of defense and homeland security applications. We clearly have many, many years of evolution and development ahead of us.

Axsys's third fundamental growth driver is our organic development of new product, which enable us to pursue new markets. Let me quickly address three such developments from the first quarter. First, in February, we introduced our new V9 airborne gimble, which we believe to be superior to other products on the markets in virtually every technical specification.

V9 is based on the successful technical architecture that we implemented in our MS-2 product, which by the way was the platform used for the security and surveillance at the recent summit of the Americas in Trinidad and Tobago last week.

The V9 truly sets a new standard for this class of product. And it's been received to even greater enthusiasm than we have anticipated. The critical implication of this product introduction from an investors view point is that it creates new growth opportunities by enabling access to compete in markets that we could not yet... that we could not previously serve.

Similarly, we're developing products in adjacent markets. For example, we're in the final stages of developing a long range laser range finder, which we intend to offer commercially by the end of the third quarter.

Laser technology is increasingly being used in conjunction with thermal cameras and laser range finders, which measure the distance for the object being observed through the camera, are in particularly high demand. We determined that we can develop this technology with in-house capabilities and the result in product will simultaneously allow us to lower the cost on our own camera solutions and expand our portfolio of cost optical solutions.

Finally, during the first quarter we also developed and tested a prototype of a two Axsys's gyrostabilized version of our APS-15 pan/tilt system. The APS 15 is the smallest pan/tilt in our product line. And when we add gyrostabilization, this system becomes ideally suited to short range, land-based and maritime surveillance applications, where the platform on which the sensor is mounted in inherently unstable.

We're very excited about these new developments. And like V9, our laser range finder and pan/tilt developments will allow us to continue to grow our business, by enabling us to pursue new markets.

In summary, I hope that my presentation today has effectively communicated why we feel so strongly, that Axsys continues to be well positioned for growth, continued growth and success under the new Obama administration.

At this point, I'd like to hand the call back over to Steve for his concluding remarks.

Steve W. Bershad

Thank you, Scott. Thank you Dave. At the end of the second quarter, Axsys remains financially and organizationally strong. With our strong market position in fast growing ISRT markets, our existing solid backlog base and our continued development of cutting edge new products for various ISRT applications, we believe that we are very well positioned for continued growth.

This concludes our prepared remarks for this morning. And at this time, we'd like to open the call to questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Steve Levenson with Stifel. Please proceed.

Stephen Levenson - Stifel Nicolaus

Thank you. Good morning, everybody.

Steve Bershad

Good morning.

David Almeida

Good morning, Steve.

Scott Conner

Good morning.

Stephen Levenson - Stifel Nicolaus

Is Axsys developing any new products using third generation two color sensors? And if so, how do you think that it will position you relative to competitors, your current ones and does that open you up against other competitors?

Scott Conner

It's an excellent question. So, the two color and such there are other investors on there on the call. So what it means by that is, a sensor that combines mid-wave and long-wave infrared, which are too different. We serve both of those markets mid-wave and long-wave infrared today. And there is continued interest in the development of detectors that basically enabled viewer to look in both the mid-wave and long-wave simultaneously. And this is for sure going to unfold, Steve.

Now, this is still in the early development phases at the detector level. But the reason that this is actually good for us is that the lenses that enable two color are very complex, much harder in fact than what is currently used today when you're only looking in the mid-wave, but the long-wave.

So, in fact, that evolution is going to be very positive for us. And I actually hope that it occurs very rapidly to be honest. The faster it can occur the better it is for us.

Stephen Levenson - Stifel Nicolaus

But you are not there yet in other words. It's self-development stuff?

Scott Conner

Absolutely. The investment development state that the detector level at this point is those... there are companies being funded at this point to develop two colored detectors. And but those are not yet ready for primetime to put a lens on yet. But, we're hopping that it occurs quickly because as I said, that's exactly the direction we want the world to go.

Stephen Levenson - Stifel Nicolaus

Okay, thanks. And in relation to your current customers, do you find that there is more interest? Are they running out of capacity on their own ability to make optics that they are coming to you or is there some sort of shift between what they are doing in-house and what they are looking to outsource?

Scott Conner

Well, there is no simple answer to that I'm afraid. Because it's different by customer. But I will tell you that we're getting more and more demand from a broader array of customers for lenses, which would imply that either they are looking for more capacity or as we really believe they are finding that they can outsource it, that we are better price performance than they can actually... that they can do in-house because of general increasing number of request for work.

Stephen Levenson - Stifel Nicolaus

Great, thanks. And last one, with the current increase in anti-piracy, are you finding any interest or are you're hearing about any legislation that might also brought demand for shipborne equip?

Scott Conner

Oh, it's an excellent question. And you may or may not know that we are actually on some anti-piracy both in the Straits of Malacca before this stuff started occurring in Somalia. And there has been an increased interest, it hasn't lesser orders yet, although interestingly we're happened to be on the navy ship that picked up the captain out there in Somalia. We actually have a bit of long range infrared camera on the U.S. as faster out there that actually took the, I forget the Maersk, Alabama, the captain of that ship back to Somalia.

Stephen Levenson - Stifel Nicolaus

Great. Thank you very much.

Operator

Your next question comes from the line of Brian Ruttenbur with Morgan Keegan. Please proceed.

Brian Ruttenbur - Morgan Keegan and Company, Inc.

Yes. Great quarter. Question I have is about sale of the company. I know you can't make a whole lot of comments. But with such great prospects, can you talk a little bit about the logic for basically a auction process that you're running and then I have some follow-up, just minor questions.

Steve Bershad

Okay. Well, I do hope you appreciate the constraints we're operating under it. And I can't tell you how strong the admonition from both our lawyers and our bank resistant to be very circumspect in what we say here. But I think what I should do is reiterate.

What we said, when we announced the process. And, of course, you can recall that that we got no intention of announcing this process when it actually got leaked. But what had happened was we had... our stock price had gone down quite a bit like everybody else's. And I think there are always been a certain amount of interest out there in Axsys by other companies. But the decline in price made it particularly attractive for some of these guys and we started getting calls.

I think it's always been... certainly it's been my intention. And I think it's our Board's intention to consistently focus on maximizing shareholder value. And I'd take it pretty seriously and our responsibility to evaluate serious approaches to Axsys. Of course, I report to the Board all the time and it's something that we are constantly considered.

This particular time we were getting quite a few, and I concluded as well as the Board that it was only appropriate that we evaluate these different approaches in the context of an organized process. As a result, we've retained a banker. And they are proceeding on that process.

I think that's about what I can say all that I can add to that is that we are going to evaluate the proposals that we received as a result of this process. The contexts of everything that's got outlined in terms of our future opportunities. And we're going to ultimately make a decision of what will create the greatest value for shareholders.

Brian Ruttenbur - Morgan Keegan and Company, Inc.

Okay. And then, thank you. The follow-up questions. SG&A expense and R&D expense, should these hold flat from Q1 levels or should those trend up? And then also on tax rate. Can you talk about tax rate going-forward?

David Almeida

Sure. R&D for the year we expect to be a percentage, right now in Q1 it was 4.1% of sales. For the full year, we expect it to be a slightly higher than that, maybe up to 4.3, but it will be right around that range.

And SG&A will be close to the levels that we're seeing in Q1. We should see our margins, our gross margins are going to come up as we move through the year, which you're going to get us those higher operating margins that we have built into our guidance.

Brian Ruttenbur - Morgan Keegan and Company, Inc.

Okay. And then tax rate?

David Almeida

And tax rate, we're looking at between 36 and 37% for the year.

Brian Ruttenbur - Morgan Keegan and Company, Inc.

Okay. And you said gross margins to get a trend up. We're talking from 34, I mean from 33 to like 34% by the end of the year?

David Almeida

Yeah. I mean our gross margins is certainly can fluctuate easily within... from quarter-to-quarter, a 100 basis points. But, as we move through the year, we expect that our surveillance business is kind of the a larger percentage of the pipe as we move forward, which carries high margins, they carry the load and importing type of margins, versus imaging group, which are 30% margins. So that's going to lift the margins just naturally as well as the fact that our volume is going to increase in the level of our plans, more as we move throughout the year.

Brian Ruttenbur - Morgan Keegan and Company, Inc.

Great. Thank you very much.

David Almeida

You're welcome.

Operator

Your next question comes from the line of Paul Coster with JPMorgan. Please proceed.

Paul Coster - JPMorgan

Thank you. Good morning. Very pleasantly surprised by the backlog number, which I thought might slide a little bit here. Can you just give us some sense of what contributed to that backlog? And also, in the contrast of Steve's prepared remarks, the pipeline which kind of is very full still, what is filling that pipeline in terms of the types of customers' geographies and types of products?

Scott Conner

Sure. Let me get the first one first. The first question, which is how the quarter unfolds. Because in fact we did have lower than expected bookings in the first couple of months, really I mean in fact maybe a month and half of the quarter. Well, I can't point specifically to it. We think that there is probably a likelihood that it was change in the administration that caused some delay. But we're quite strong bookings actually in Q4, and excuse me, in the month of March. As a result, we are pretty pleased with the result as well.

And now to the second point about the pipeline. The pipelines needs to roll pretty broad based. You mentioned geographies and product types. And it's hard for me to point to a specific thing. We're getting demand for... continue the pipeline growth for force protection, for our existing MS-2 gimbal. There is increasing demand in pipeline growth for our new V9 gimbal that I alluded to in our call. The continued demand and opportunity in the lens world, and I'll tell you emotion control also continues the pipeline continues to grow very effectively which are you may or may not know is our motion control is heavily influenced by targeting systems, infrared most specifically. And that demand for increased advancements and those types of technologies is leading to more motion control demand as well.

So, really across the board, there isn't one thing I can point to. There are actually strong pipeline growth in really all areas of the business.

Paul Coster - JPMorgan

Is there anything about the shift of military resources to Afghanistan that has some implications for you?

Scott Conner

Yeah. Well, I wish I could give you answer of that with confidence. I will tell you that what we've been told anecdotally is that, that should lead to more surveillance, more enforce protection work. But I don't... I can't give you hard facts on that I'm afraid.

Paul Coster - JPMorgan

Got it. David, is there... are there any stats you can share with us regarding the international revenues, competition thereof and customer concentration?

David Almeida

International --

Scott Conner

Let me just address. I cant from the quarter, but I can in general.

Paul Coster - JPMorgan

Right, okay.

David Almeida

So let me, I'm going to have to break it by segments because the imaging segment is large... is really dominated by U.S. There is some international, but basically because so much of the platform spending is in the U.S. that really drives the vast majority of our revenues.

On the surveillance side, it's much more mixed. And it's probably around 30%, let's say is international. And that has a lot of potential for growth to be quite honest. I mean we have a maturing I'll say international distribution channel. It's something that our President of that Group, Dan Manitakos, is working hard on it and maturing that international distribution channel. And that has a lot full go out of firm because we're really not addressing some international markets that whether is definitely is demand.

And so that's one of the things that we're working on. And I think you'll see that that percentage increasing over time, both as surveillance becomes a bigger percentage of Axsys's revenues, and I think within surveillance, you'll see more international sales, within the surveillance group. So that's the first part of question. I'll let David here.

David Almeida

Right. And as far as concentration goes, I mean last year 2008, we had one customer over 10% that representing over 10% of revenue to BAE, which represents 23%. The first quarter we actually had three customers as you could see in the Q filing, BAE, Northrop Grumman and Raytheon that represented over 10% of our sales. But, of course, those are spread over a number of different programs.

Paul Coster - JPMorgan

Excellent. Thank you very much.

David Almeida

You're welcome.

Steve Bershad

Thanks Paul.

Operator

Your next question comes from the line of Michael French with Morgan Joseph. Please proceed.

Michael French - Morgan Joseph & Company Inc.

Good morning, gentlemen. And congratulations on the strong performance.

Scott Conner

Thanks Mike.

Steve Bershad

Thank you, Mike.

Michael French - Morgan Joseph & Company Inc.

Scott, if I can just use follow-up on the comment you made that March being strong, has the strength continued into April?

Scott Conner

Well, I can't. I don't really want to comment. On the quarter, we haven't concluded yet. But I think we had unusual softness in bookings in the first, maybe month and half of Q1. Then it returned really some more effective, quite strong at the end of the quarter. But some of that I think was make up, where people were holding back orders, seeing what the implications are, which way the defense spending was going to go. And I think it's more to normalize level. Let me just say that.

Michael French - Morgan Joseph & Company Inc.

Okay. And then back to your prepared comments, particularly the two new products that are developing the range finder and the pan/tilt. So, if you can discuss the market opportunities there?

Scott Conner

Sure.

Michael French - Morgan Joseph & Company Inc.

And timing on the pan/tilt, you mention the rangefinder in 3Q? And then, sort of in a more broad sense. Secretary, Gates didn't provide a lot details in terms of how they would spend the increased funding. But are you anticipating how they would spend it and developing new products or thinking of ways to increase the marketing on the product sheet do you have?

Scott Conner

Sure, sure. That's a lot. To answer those questions, that's a lot. So, I'm going to my best to be as concise as possible. So, the pan/tilt also I would say Q3, I'd say each of those the pan/tilt market is probably $50 million market and the rangefinder market costs, I'm talking about purely costs here, is probably about $100 million market; that's external. Both of those products, however, were... the business case was quite easy because we can actually pay for them just by cost reduction and our own solutions, for our own camera solutions. So that really is the motivator. But, of course, then we can apply and sell those products externally as the cost product, which is what our intent is.

To your second part of your question which was about the Gates memo. There is a broad trend towards cost effective ISRT, which really we translate to costs. More cost solutions for surveillance test, commercial off-the-shelf product, not customized solution. Because there is hardly, also as I mentioned in my prepared remark, ISRT buy almost like major, in fact is a high value for dollar type of technology, which is why the big emphasis I think from Secretary Gates.

I can't point to specific programs that are going to result in the sale of cost products. So the only thing that... that's why in my prepared remarks I focused on the only things that I could point to specifically which were SM-3, THAAD and Joint Strike Fighter, the latter which resulted into much higher numbers than we had expected. I mean we had projected, so that program maybe $40 million over the next five years. And it's more like based on these numbers at least greater than 80 million, and over the life of the program, it really could be as I said $350 million or more that program for us. So, it's a very exciting development in fact.

Michael French - Morgan Joseph & Company Inc.

Okay. Thank you and good luck.

Scott Conner

Thank you.

Operator

Your next question comes from the line of Michael Ciarmoli with Boenning & Scattergood, Inc. Please proceed.

Michael Ciarmoli - Boenning & Scattergood, Inc

Hey guys. Good quarter. Thanks for taking my call.

Scott Conner

Thank you.

Michael Ciarmoli - Boenning & Scattergood, Inc

I guess Scott, can you comment on where you are in terms of your utilization at the Nashua facility, and when we can expect kind of the overhead pressure on margins to elevate there?

Scott Conner

Oh, that's a good question. So, we're growing, I mean but again maybe a more complex answer than you don't want to here. But we still... we did the Nashua facility. Where we are running on constrains is in the gimbal area. And that's actually out in California. And when we put the new facility in the Nashua, we actually lacks space specifically to move to... for the full rate production of higher volume gimbals would be manufactured in that facility.

So there is extra space, that's not really utilized in that new facility in expectation of manufacturing. And we're going to be developed. In fact, we're going to be moving our full rate production gimbal work there in Q3 of this year. And as growth occurs from Q3 and beyond, you will see that overhead offsets.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay. That's extremely helpful. And then you mentioned some margin pressure due to a new infrared lens project. Can you elaborate on what sort of use is that projects for, maybe is there a specific customer or program that the lenses geared towards or is this just kind of you're looking at the market opportunity and going out with the new lens?

Scott Conner

No. There was a new TWS program, a new TWS customer that we discussed in the past, that this is the beginning of the ramp.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay.

Scott Conner

And looking at the ramp, it's just had lower margin as is often the case. At the beginning of the ramp there is definitely lower margins than as you grow those margins, you grow those revenues, you get comfortable with how to fill that products. Your margins can grow back to normalized level. And in Q1, we'll beginning that ramp which of course led to the lower margins.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay. And then just staying on if you can, staying on the thermal weapon side. What percentage if you can elaborate of revenue was TWS? And I guess if I won a few mile lump in CROWS if you can disclose, what percentage of revenues those contributed to the quarter and what percentage do those programs represented backlog?

Scott Conner

Yeah, we don't break that out by either backlog or program. What we do breakout and as you know that TWS and CROWS are both at least part of the TWS is from BAE and the CROWS partner wit BAE. And so you can see BAE's concentration, which we do disclose.

Michael Ciarmoli - Boenning & Scattergood, Inc

Yeah.

Scott Conner

We don't disclose by program, either results or in backlogs.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay. And then BAE just got $138 million order I think towards the end of March. Is that in your current bookings or is that expected to hit in the next quarter for you guys. I think they got an order --

Scott Conner

I really don't want to answer that, although let me just say I don't want to answer that specifically. But let me just say that we're manufacturing at a steady... at a rate that we expect and we don't expect at that manufacturing rate to change. We have it all planned in. And when you see those bookings, it should not affect. The bookings are lumpy just like our own bookings and they come in but the manufacturing level, the shipment level is actually fairly well defined.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay.

Scott Conner

Okay?

Michael Ciarmoli - Boenning & Scattergood, Inc

Perfect. But then I've got two more quick ones. Do you know what the status of the driver vision enhancer program is? I know you guys talked about it, it's only going to modest revenues. But do you know where that stands right now?

Scott Conner

I don't, I don't.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay.

Scott Conner

And we're still hopeful because it could actually... could be a good... it would be modest revenues in 2009. But it could be a big program over many years, a multiyear long running program, but it wouldn't affect 2009 very much.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay. And then last question and I'll jump off. On your surveillance systems segment, you're obviously developing a range of new products or building up your sales and distribution channel. Is it still the indirect type model and do you expect to bring that in-house to sort of a direct sales model to kind of hopefully save some margin points there?

Scott Conner

Well, it's a blended model now.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay.

Scott Conner

Definitely with a lot emphasis on third-party as you suggest. And there is no plan to change that dramatically, not that you'd see it in the margins in the short run.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay.

Scott Conner

So, over the longer term, we have to evaluate that as it comes.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay, perfect. Thanks guys.

Operator

Your next question comes from the line Tim Quillin with Stephens Incorporated. Please proceed.

Tim Quillin - Stephens, Inc.

Good morning.

Scott Conner

Good morning, Tim.

Steve Bershad

Good morning.

Tim Quillin - Stephens, Inc.

In terms of gross margins in the surveillance business, you've given the utilization in the Nashua facility. Would you expect gross margins for the year in surveillance to be flat or down year-to-year?

David Almeida

They should be close to the levels that they were in 2008. In 2008, we were at 43.4%. First quarter, of course, they were down 100 basis points, 42.1. Again, they are going to fluctuate from quarter-to-quarter and there maybe a quarterly at 45. And again and then, of course, we'll hit 42 somewhere around there too. So, I think to expect those levels to be at where they were in 2008 or possibly a little higher as we level the top line I think is practical.

Tim Quillin - Stephens, Inc.

Okay. And then, and probably strong around the back half of the year as you have some production capacity there.

David Almeida

Correct, correct.

Tim Quillin - Stephens, Inc.

And in terms of imaging, do you expect a relatively quick bounce back to more traditional 30% gross margin in 2Q after you get passed startup costs on TWS production?

David Almeida

Q2, in particular, I will comment on. But yeah, I think for the year we expect the margins for that business to be around, it's a 30% margin business.

Tim Quillin - Stephens, Inc.

Okay. And then on SG&A, you... in dollar terms you were down year-to-year for the second quarter in a row. Is there specific cuts in specific areas that you're making or what is exactly is going on there?

David Almeida

No. Just kind of controlling our spending overall across several areas, whether be at corporate world within our divisions. And some of it also just relates to timing as well. You know there is some quarters, trade shows falling into and stemming entire. So, no one specific reason really.

Tim Quillin - Stephens, Inc.

Okay. And on the CROWS program you had received I think in May of last year about a $17 million order, and that you said its time would mostly ship in '09. And then you received a $50 million order that you said would pretty much all shipped in '09. So it implies that you're getting pretty close to a $30 million run rate on that program, should we look for any kind of milestones to help keep that growth going in 2010?

David Almeida

I would just look for continued bookings like that, that you're referring to, exactly what the leading indicators of that program specifically.

Tim Quillin - Stephens, Inc.

Okay. Okay. And in terms of TWS, are you getting, do you get small orders as well or should we expect large orders that you'd put out press release on that?

David Almeida

No we have... as we have put out large orders on that in the past and will continue to do so.

Tim Quillin - Stephens, Inc.

But are you getting an addition to that smaller orders that are not press released?

David Almeida

Oh, yeah. I mean, on that programs?

Tim Quillin - Stephens, Inc.

Right?

David Almeida

Yeah, occasionally, if they were quite small. We only announced whenever over, let's say, I think our general rule funded $4 million or so.

Tim Quillin - Stephens, Inc.

Okay. Okay. And then just last question with regards to your sales process. When did it start, when did you... when were did you have overtures and when did you hire a banker? Thank you.

David Almeida

I'm going to have to pick that up. I think that's horribly something that we're constrained to talk about. So I would rather not answer that specifically.

Tim Quillin - Stephens, Inc.

Thank you.

Operator

(Operator Instructions). Your next question comes from the line of Tyler Hojo with Sidoti & Company. Please proceed.

Tyler Hojo - Sidoti & Company

Hey, good morning guys.

Steve Bershad

Good morning Tyler. How are you?

Tyler Hojo - Sidoti & Company

Good, thanks. Hey, I just want to go back to the backlog for a second. Obviously, looking back to kind of 2006, we haven't seen two consecutive quarters of book-to-bill south of one, which is kind of the case now. And I just kind of wanted to get your thoughts on that? I guess you said there was some slippage with the new administration, but it certainly doesn't seem like there's any concern on that. But I guess what's giving you confidence in kind of holding your guidance just in light of where the actual bookings are?

Scott Conner

Sure. I think it's hard to convey, but a lot of our programs are... what we call it soft backlog. So, we know what's in our backlog and we know what's going to book with pretty high degree of certainty. And if that slips by a month, let's say some of these larger booking, we still know it's going to come. We are in very close contact with a lot of these customers. And so it's not like we're hoping a prayer. We're embedded on a huge number of programs that we have a lot of inside into. And so we... as a result we have a high degree of confidence that they are going to book in contrast to ship. In fact we often know when those shipments are going to be required by the customers. And in some instances they are basically even funding as an advance to make sure we have the materials to keep going even though we don't have bookings yet.

So, we have a pretty high degree of insight and so where those bookings are going to be. And that's why in many of these conference calls we just sway people from concentrating on the booking in a particular quarter because we have and instead focus on our guidance because we do have pretty good confidence to where these revenues are going to fall.

David Almeida

One booking could have shifted that number in Q1 from a negative to a positive book-to-bill.

Tyler Hojo - Sidoti & Company

I understand. But your expectation I guess on a full year basis would be that your backlog grow through your bookings trend would kind a match your revenue growth. Is that fare or is something kind of shifted just in regards to or maybe increased booking ship business?

Scott Conner

Well, let me just the over time, no, I'm not sure how I'm going to answer your question. But let me try. The surveillance business is a higher booking ship business. And there is a higher degree of booking ship than the imaging business.

Tyler Hojo - Sidoti & Company

Right.

Scott Conner

And so, over and as we fully expect that surveillance business is going to grow faster over time than the imaging business. And so by definition just the math, you're going to have a higher percentage of booking ship, assets will over time. And that fluctuates of course within particular year depending on when these bookings are going to come in. But yes, if you actually look back in the next five years you will see, if after five years you look back, you're going to see that the business has transformed to more booking ship than it is today.

David Almeida

Right. I mean we expect the positive book-to-bill over the course of the year. We don't really relate that back to these gross rates for the year because when that backlog is shippable, as it rolls out, it may be quite different than the growth rates and the time period that you are looking at. So.

Tyler Hojo - Sidoti & Company

All right. That's --

David Almeida

That helps?

Tyler Hojo - Sidoti & Company

Its does help yeah. And just kind of a follow-on to that. Earlier this month, there is a pre-solicitation with your guys kind of named it as a sole source for spare beryllium telescope. Just wondering, if that's something that's meaningful coming down to pipe or just kind of something standard?

Scott Conner

Honestly, I don't even know. I don't know what is it. I mean frankly. I mean if it's a beryllium telescope that would be right smacked at in our wheelhouse. So I wouldn't be surprised at all. But I honestly don't know the specific telescope you are referring to.

Tyler Hojo - Sidoti & Company

It's... I don't know its GLAS or glass spare beryllium telescope?

Scott Conner

I'm afraid I don't have... its not ringing a bell.

Tyler Hojo - Sidoti & Company

I'll shoot it over to you.

Scott Conner

All right, please do.

Tyler Hojo - Sidoti & Company

Okay. Thanks a lot guys.

Scott Conner

Sure.

David Almeida

Yes.

Operator

Your next question is a follow-up from the line of Michael Ciarmoli with Boenning & Scattergood. Please proceed.

Michael Ciarmoli - Boenning & Scattergood, Inc

Hey, thanks guys. Dave, quick follow-up. I might have missed it. You said your free cash flow conversion for the year was what?

David Almeida

We expected it to be around 65%.

Michael Ciarmoli - Boenning & Scattergood, Inc

65%. Okay. And then last one, Dave or Scott, I'm sorry, I don't remember Northrop Grumman ever being that high in terms of customer percentage. Are there... I know you've got the C-RAM program that obviously manufacturing some of the UAVs. Are there any other program at Northrop that we should be tracking that are of importance or is anything new come online there?

Scott Conner

The reason that that has increased is because, it's a very broad array of programs actually that comprise that Northrop Grumman, Inc. And that, we supply them both on vehicles that they are on. And so we're supplying as from the imaging side and Northrop Grumman also is a large integrator for us. So, when you're on a program where they are putting in say, a forward operating base, protecting the perimeter, they may be doing the work that actually puts the poles up and integrates the bunch of technology. So we would sell a camera solutions to them as part of their broader surveillance, integrate surveillance solutions. So, the combination of those has actually just filled up in a larger percentage.

Michael Ciarmoli - Boenning & Scattergood, Inc

Okay. That's helpful. Thank you.

Operator

At this time, there are no additional questions. I would now like to turn the call back over to Mr. Stephen Bershad for closing remarks.

Steve Bershad

Thank you, operator. And thank you everyone for joining us this morning. We're pleased to deliver another quarter of strong growth for our shareholders. And we appreciate your continued support. We look forward to updating you on our achievements in the coming months. Thank you.

Operator

Ladies and gentlemen, this concludes the presentation today. You may now disconnect. Thank you. And have a good day.

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